Japan needs China's business and pacified US-China relations

An increase in Japan’s exports to China was key to the country’s entirely export-driven 1 percent growth in the first two quarters.

But all that could be an easily reversible work-in-progress because Japan is a direct participant in a turbulent U.S.-China relationship.

China has kicked the door ajar and is now watching how Japan will behave in a maelstrom of Washington-Beijing dealings.

There are few, if any, world leaders that could match the clarity of Japanese Prime Minister Shinzo Abe’s China strategy.

Having led the Liberal Democratic Party to a resounding election victory, Abe declared in December 2012 that “China is an indispensable country for the Japanese economy to keep growing. We need to use some wisdom so that political problems will not develop and affect economic issues.”

That was very clear, but the implementation of that strategy sounded like squaring a circle.

Over the next six years, Abe tried everything. Pressed by his virulently anti-Chinese constituency, and encouraged by the Obama administration’s China-hostile “pivot to Asia,” Abe started out with confrontation and direct competition with China’s search for an expanding global footprint.

Realizing the futility of that approach, he hesitantly changed to a more cooperative and friendlier posture — effectively turning into a supplicant for contact and attention with an aloof, hostile and indifferent Chinese leadership.

Abe’s original mistake cost him trust — the most precious asset in dealing with China.

China is testing

The Japanese prime minister’s state visit to China last week was therefore a triumph of persistence — six years of an incredible political tour de force.

Careful, though. Abe is on probation (just take a look at that handshake at the Diaoyutai State Guesthouse). China is now testing how far a more constructive relation with Japan may go in the context of a rapidly changing geopolitical landscape. The Chinese know that Abe flunked a similar test with Russia, which will probably cost him one of the apparently dearest objectives of his political career.

And beware this red herring: The idea that Beijing suddenly warmed up to closer relations with Japan as a result of China’s weakening economy and a trade dispute with the U.S. is arrant nonsense.

In fact, China’s economy is in good shape. The gross domestic product growth was 6.7 percent in the first three quarters of this year. Inflation is stable (2.5 percent in September), public finances are sound (a budget deficit of 3 percent of GDP and public debt of $5.2 trillion, or 47.6 percent of GDP), and there is a trade surplus on goods and services of $70 billion, with a whopping $3 trillion stashed in foreign exchange reserves.

China, clearly, does not need Japan for the steady growth of its huge and rapidly expanding domestic market. And neither is China desperate for Japanese investments. According to the latest United Nations numbers, China was the world’s largest recipient of foreign direct investments in the first half of this year. During that period, China got $70 billion in FDI inflows, a 6 percent increase from the year-earlier, despite a 41 percent global decline for trans-border direct investments.

It is also ridiculous to think that China needed Japan as an ally in its trade dispute with the U.S.

No, Abe’s comment in 2012 about the importance of China for Japan’s economic growth is more valid today than six years ago, and his Herculean efforts to patch up relations with China are testimony to his extraordinary dedication to his country’s welfare.

Japan’s $206.1 billion in bilateral trade with China during the first eight months of this year is by far the largest segment of Tokyo’s foreign trade transactions. The U.S., with a bilateral trade business of $143.8 billion, comes in as a distant second.

Japan is caught in the middle

A 14 percent increase in Japan’s exports to China during the January through August period is one of the key factors contributing to the country’s entirely export-driven 1 percent economic growth in the first half of this year. A 5 percent increase in export sales and a 3.5 percent increase in exports-spurred business investments have been the main growth drivers at a time when household consumption and residential investments — about 60 percent of GDP — were virtually dead in the water.

Investors and political scientists should therefore have no problem believing Abe’s statement that “China is an indispensable country for the Japanese economy to keep growing.”

The only problem is whether Japan will be able to keep the Sino-Japanese business relations immune from the worsening U.S.-China confrontations and apparent difficulties in establishing a working relationship with South Korea.

Contested territorial claims over uninhabited East China Sea islands, called Senkaku by Japan and Diaoyu by China, are a major bilateral issue. Those islands are administered by Japan and claimed as ancestral territory by China. Even in an unlikely case that Beijing and Tokyo agreed to — again — put that matter to the side, China regards that problem as an intolerable infringement on its sovereignty and territorial integrity.

Today’s China is very different from that impoverished great nation that, in 1978, agreed with Tokyo to leave the territorial issue for future generations in order to conclude the Treaty of Peace and Friendship. At that time, China was looking for trade, technology, investments and financial assistance from Japan. As the numbers above show, China is now a very different country.

And the U.S. is in the middle of the China-Japan territorial row. While declaring neutrality in that particular dispute, Washington did clarify in September 2012 that the Article V of the U.S.-Japan Security Treaty (The Treaty of Mutual Cooperation and Security between the United States and Japan) clearly covered the Senkaku/Diaoyu islands because they were effectively controlled by the Japanese government.

But that is only one of the problems the U.S. has with China where Japan can become directly implicated. Washington does not accept China’s air and maritime borders in the East and South China Seas. Clashes of air and naval assets are now increasingly frequent as the U.S. and its allies conduct freedom of navigation operations, including in the areas around the Senkaku/Diaoyu islands.

Investment thoughts

Abe deserves praise and respect for years of relentless efforts to keep open the access to China’s huge markets for Japanese businesses.

But all that is an easily reversible work-in-progress.

It is not a simple scheduling coincidence that Chinese President (and the Chairman of the Central Military Commission) Xi Jinping came to Beijing last Friday to greet his Japanese guest after a thorough inspection of the army’s southern theater command, where he called for “advanced commanding ability” and a strong military “for the new era.”

China has shrewdly kicked the door ajar and is now watching how Japan will behave in a maelstrom of U.S.-China relations.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.